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| Beijing: Current legal framework is not clear | |
Edmund Ho, managing director and co-head of real estate and lodging for Asia-Pacific at Citi, says REITs hold promise in the long term as the property market in China matures. “The China property market has just developed during the past 10 years,” he explains. “As the sector develops and rentals for quality investment properties become more mature and stable, launching REITs makes sense.”
Ho points out that many Chinese property companies that had built office buildings or shopping malls sold off their units, so they do not currently have enough investment property portfolios to put into REITs. At the same time, the new projects that have come onto the market in recent years command lower rentals in order to attract new tenants, so the current rental yields are low compared with the valuation expectations based on subsidized rentals. “It will take a bit longer for these assets to mature and for rentals to become stabilized,” he says. “But once they do, the current rental yield and valuation will be more cohesive.”
Regulatory issues
In addition to letting the market mature, there are regulatory issues hounding the launch of REIT transactions. “The current legal framework for REITs in China is still unclear,” says Vivian Lam, a partner at the law firm Paul, Hastings, Janofsky & Walker. “Other jurisdictions such as the UK, Hong Kong and Singapore have passed specific legislations in recent years to enable the launching of REITs, but China hasn’t. We can only work within the current regulatory environment and look for guidance from the authorities where things are unclear. If someone can push the first deal, others will follow.”
Ho says China needs a strong trust law in order to develop the REIT market since REIT is based on trust and there is a need for strong investor protection. “There is a trust law in China and most trusts in China are private,” he explains. “The implementation and the monitoring must be strong enough to protect the interest of the unit holders for listed REITs to be effectively developed. That part needs to be tested first. REIT itself is very simple, but having the trust to hold the assets on behalf of the unit holders is an important piece of the jigsaw to make REIT work.” In addition, Ho points out, there are other issues that need to be considered such as whether Chinese valuation reports can be relied upon and the tax regime for REITs to make them more transparent.
Lam says the government measures to cool down the property market, such as tightening credit and restricting foreign investments in China’s real estate sector, have strengthened the argument for developing the China REIT market. “REITs are in line with government policy because they are not a speculative instrument,” she says. “Its
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| | Lam: REITs diversify risks |
primary aim is to provide steady returns to investors from rental income, not from trading of properties.”
From the developers’ point of view, Lam says REITs provide access to capital through the monetization of their assets, while giving them the option of retaining a stake in the REIT for capital appreciation and to enable them to participate in the management of the asset/property. REITs can also serve as a platform to promote good management and higher standards of corporate governance and, further down the road, to inject future properties into the market. “For the long-term development of the real estate market, the government should encourage domestic REITs as a form of financing to diversify real estate financing risks away from banks and provide Chinese investors with more choices to participate in the real estate market.”
REITS as alternative funding vehicles
For investors, the benefits include the ability to invest in a portfolio of properties, easy exit, continuous pricing, lower gearing and high distribution. But some investors look at REITs for different reasons. “They are looking for capital appreciation like they see in property developers, before the recent market correction,” Ho laments. “If they can achieve a total return of 10% to 15% from REITs, investors should be happy.”
Ho adds: “REITs are a different investment instrument and serve a different purpose. Apart for long-term valuation growth and constant dividend stream, one other key purpose is more stability to help investors lower their overall investment portfolio risks at the expense of slightly lower potential returns. If investors look at REITs that way, the REIT market should become more mature and it should trade better.”
Indeed, REITs can be an excellent funding vehicle for Chinese real estate developers at this time when other channels have been tightened or even been closed since the fourth quarter of 2007. A report by Standard & Poor’s (S&P) notes that developers historically were able to use their presale proceeds to finance the acquisition of new projects, but weakening sales have made this difficult, if not impossible. In addition, as the government tightens controls over the banking system, potentially demanding closer supervision of the use of presale accounts, it will be increasingly hard for companies to rely on presale proceeds to aid expansion.
Developers, S&P adds, are not allowed to pay for land premiums through domestic bank borrowings. For development loans, credit lines have become harder to obtain and funding costs are rising. As a result of the tightened policies, banks are more selective about lending – and often will only lend to companies with strong credit profiles.
But for some property developers such as Shimao Property Holdings, REITs are not in their pipeline at the moment. “A REIT is not on our current plan as our investment properties are not yet mature, but we are always open to any channel to maximize shareholders’ return and reflect the true value of our investment properties,” says Shimao executive director Jason Hui.
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Lam: REITs diversify risks
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China REITs listed offshore
What the REIT structure requires is the establishment of an investment vehicle with the objective of producing a stream of rental income from the passive ownership of real estate properties and having most of that income distributed to investors as dividends.
So far, REITs containing China property assets have been launched in Hong Kong and Singapore. But as Ho points out, launching a REIT with Chinese assets in Hong Kong faces structural issues. “You need to move the assets from onshore to offshore ownership and that will have a huge tax implication,” he says. “The transfer will require payments of stamp duty and potentially profit or land appreciation tax. Effectively, you are paying a lot of cash upfront in order to launch a REIT listing offshore.”
The groundbreaking GZI REIT was the first offering with a portfolio of China-based real estate assets to list in Hong Kong in December 2005. It was also the first REIT to invest in Guangzhou and the assets comprise a portfolio of four commercial properties. The way this deal was structured and the assets held offered a novel template for investors eager to tap the value of commercial portfolios in China.
As of December 31 2007, the properties of GZI REIT were valued at about HK$4.7 billion (US$602.6 million), up 10% from a year ago. The distribution per unit at year-end amounted to HK$0.2258, compared with HK$0.2067 in 2006.
Other landmark deals followed and in December 2006, CapitaRetail China Trust (CRCT) became the first REIT to list in Singapore with a portfolio made up solely of China-based assets. Its current portfolio consists of eight retail mall properties located in Beijing, Shanghai, Zhengzhou, Hohhot and Wuhu. As at March 31 2008, the total asset size of CRCT was about S$1.1 billion (US$785.7 million).
